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A Fund Manager's Overview to Dodd-Frank


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									A Fund Manager’s Overview to Dodd-Frank
    Dodd-Frank Wall Street Reform and Consumer
                  Protection Act

 On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
  Reform and Consumer Protection Act (the “Dodd Bill”) into law.

 Numerous aspects of the Dodd Bill impact non-U.S. private fund managers.

             Definition of an "accredited investor"
The Dodd Bill revises the definition of an "accredited investor" under the Securities Act of
1933 ("1933 Act").
Definition pre-Dodd:
   An "accredited investor" is deemed to include, in part:
   A natural person with an individual net worth, or joint net worth with his or her spouse, at the time of
    purchase in excess of $1,000,000;
   A natural person with an individual income in excess of $200,000, or in excess of $300,000 with his or
    her spouse, in each of the two most recent years and who has a reasonable expectation of an income
    in excess of $200,000 individually, or in excess of $300,000 with his or her spouse, in the current year;
   Any executive officer, director or general partner of the issuer of the securities offered;
   An employee benefit plan within the meaning of Title I of the Employee Retirement Income Security Act
    of 1974, as amended ("ERISA"), (a) whose investment decisions are made by a plan fiduciary, as
    defined in Section 3(21) of ERISA, which is either a bank, insurance company or registered investment
    adviser; or (b) having total assets in excess of $5,000,000; or (c) if self-directed, the investment
    decisions are made solely by persons that are accredited investors;
   A trust, with total assets in excess of $5,000,000 which was not formed for the specific purpose of
    acquiring an interest in the hedge fund, whose purchase is directed by a sophisticated investor; and
   An entity in which each of the equity owners are accredited investors.

 Definition of an "accredited investor" (cont.)

 Under the Dodd Bill

    The value of a natural person’s primary residence must be excluded
     from the $1 million net worth calculation.

    In all other respects, the definition of “accredited investor” under the
     1933 Act remains the same.

    This change in definition was effective immediately on July 21, 2010.

   Definition of an "accredited investor" (cont.)

 The Confidential Private Placement Memorandum and Subscription Documents for
  3(c)(1) privately placed investment funds should be revised immediately for this new
  definition of "accredited investor".

     Non-U.S. domiciled 3(c)(1) investment funds that accept individual U.S.-based
      investors (including individuals that invest through a self-directed IRA);

         • We note that many non-U.S. domiciled 3(c)(1) funds only accept institutional
           U.S. tax-exempt investors which will not be affected by the new definition of
           an accredited investor for individuals; and

     U.S. domiciled 3(c)(1) funds that accept individual U.S.-based investors.

     Definition of an "accredited investor" (cont.)
         “Which investors are not affected?”

 We do not currently believe that you need to recertify existing investors in
  your hedge funds that are not making additional capital contributions.

 With respect to private equity funds, if an investor has already made a
  capital commitment to the fund, we do not believe that subsequent draw-
  downs of capital by the fund from such investor will require you to recertify
  such investor.

      Definition of an "accredited investor" (cont.)
             “Which investors are affected?”

 Absent further guidance from the Securities and Exchange Commission ("SEC"), we
  currently believe that the new "accredited investor" definition only applies to:
    (i) investors making an initial investment in 3(c)(1) funds; and
    (ii) existing investors that make an additional capital contribution in a 3(c)(1)

 As with hedge funds, any investor that is making a new capital commitment to a
  private equity fund would need to meet the new definition of "accredited investor".

 Accredited Investor/Qualified Client Standard to be
         Reviewed and Adjusted by the SEC
 The Dodd Bill lays the groundwork for future changes to the "accredited investor"
  definition, apart from the net-worth test, with requirements for the initial review and
  subsequent reviews:

      Initial Review - The SEC may review the definition of “accredited investor” as it
       applies to natural persons to determine whether adjustments are appropriate for
       investor protection, in the public interest and in light of the economy;
      The SEC cannot modify the net worth standard during the first four years after
      Subsequent Review – Not earlier than four years after the date of enactment and
       not less than once every four years thereafter, the SEC must review the definition
       of “accredited investor” in its entirety, as applied to natural persons, and
       determine if adjustments are appropriate for investor protection, in the public
       interest and in light of the economy. After completing the review, the SEC may,
       by notice and comment rulemaking, adjust the definition of “accredited investor.

                Investment Adviser Registration

 The Advisers Act will also be amended to require many investment advisers that are
  currently exempt from registration with the SEC to register.

 The Dodd Bill requires all investment advisers to hedge funds and/or private equity funds
  that manage $150 million or more in assets to register with the SEC.

 The new rules under the Adviser Act will become effective on July 21, 2011.

         Investment Adviser Registration (cont.)

 The "private adviser" exemption is being eliminated. The "private adviser" exemption
  enabled an investment adviser to avoid SEC registration if it:

     did not act as an investment adviser to a registered investment company or business
      development company;

     had fewer than 15 clients (counting each fund as 1 client); and

     did not hold itself out to the public as an investment adviser.

        Investment Adviser Registration (cont.)

 Investment Advisers with $24-100 million AUM:

     will be prohibited from registering with the SEC if the investment adviser is required
      to register with a State:

     would be subject to examination by virtue of such State registration; and

     although such investment advisers may register with the SEC if they would otherwise
      be required to register with 15 or more states.

        Investment Adviser Registration (cont.)

 Investment Advisers with $100-150 million AUM:

     are required to register as an investment adviser with the SEC.

     the SEC is required to provide an exemption from registration under the Advisers Act
      for an investment adviser that acts solely as an investment adviser to private funds
      with AUM in the U.S. of less than $150 million.

     investment advisers managing between $100 and $150 million AUM that do not
      satisfy this exemption must register with the SEC.

     investment advisers exempted under this provision will be subject to recordkeeping
      and reporting requirements that the SEC determines necessary and appropriate.

        Investment Adviser Registration (cont.)

 Investment Advisers with $150+ million AUM:

     will be required to register with the SEC, unless they are exempt pursuant to one of
      the other exemptions contained in the Advisers Act.

 Private Equity Funds:

     The Dodd Bill does not provide an exemption from SEC registration for investment
      advisers to private equity funds.

        Investment Adviser Registration (cont.)

 Venture Capital Funds:

     Investment advisers that manage only venture capital funds are exempt from SEC
      registration. They are, however, required to maintain records and provide reports to
      the SEC, the content of which is to be determined by the SEC.

     The SEC is required to determine the definition of “venture capital fund” within one
      year of the enactment of the Financial Bill.

 Family Offices:

     The Dodd Bill exempts “family offices” from registration and excludes them from the
      definition of “investment adviser” under the Advisers Act.

        Investment Adviser Registration (cont.)

 Term "Family Office" Redefined:

     The SEC is proposing to define a family office as any firm that:

         • Provides investment advice only to family members, as defined by the rule;
           certain key employees; charities and trusts established by family members; and
           entities wholly owned and controlled by family members;

         • Is wholly owned and controlled by family members;

         • Does not hold itself out to the public as an investment adviser.

     Public comments on the proposed rule should be received by the SEC by
      November 18, 2010.

         Non-US Investment Adviser Registration

 Non-U.S. Investment Advisers. If the investment adviser is based outside the United
  States, they will now be required to register with the SEC. The “foreign private adviser"
  exemption includes any investment adviser who:

        has no place of business in the U.S.;
        has fewer than 15 U.S. investors in private funds in aggregate;
        has AUM less than $25 million attributable to U.S. investors in private funds; and
        neither:
           • (1) hold itself out to the public in the U.S. as an investment adviser; or
           • (2) act as:
                  – an investment adviser to any registered investment company; or
                  – a company that has elected to be a business development company.

     If an investment adviser fails to meet any ONE of the criteria, they will be required to
     register as an investment adviser.

       The SEC Registration Process for Investment

 The Dodd Bill does not specifically provide for the “registration lite” regime that currently
  applies to many non-U.S. investment advisers.

 The process of SEC registration was not changed by the Dodd Bill. Form ADV – Parts I
  and II must still be completed by the Investment Advisers. On July 21, 2010, the SEC
  approved changes to the check-the-box format of the Form ADV Part II. The SEC now
  requires SEC registered investment advisers to provide new and prospective clients
  with a brochure and brochure supplements written in plain English.

       The SEC Registration Process for Investment
                     Advisers (cont.)
In addition to the existing disclosure requirements, the new ADV Part II must now:

      Indicate whether advisers hold themselves out as specializing in any particular
       type of advisory service;
      Disclose the total assets under management;
      Describe how advisers are compensated for advisor services, provide a fee
       schedule and disclose whether fees are negotiable;
      Disclose conflicts of interest that arise from accepting performance bases fees;
      Explain that investing in securities involves risk of loss that a client should be
       prepared to bear;
      Describe any material risks that are specific to a particular strategy;
      Disclose material facts about any legal or disciplinary event that is material to a
       clients evaluation of the advisory business or the integrity of management
       personnel; and
      The new ADV Part II must be filed electronically.

          The SEC Registration Process for Investment
                        Advisers (cont.)
A non-U.S. investment adviser which is required to fully register with the SEC, must,
in part:

       appoint a Chief Compliance Officer;
       establish written Policies and Procedures;
       adopt a Code of Ethics, including personal trading reporting;
       perform an annual review of the firm’s policies and procedures; and
       comply with the Custody Rules.

 Other Provisions Directed at Investment Advisers

 New Recordkeeping and Reporting Requirements. Registered investment advisers will
  be required to maintain records for each private fund they advise, describing the:

         •   Amount of assets under management;
         •   Use of leverage, including off-balance sheet leverage;
         •   Counterparty credit risk exposure;
         •   Trading and investment positions;
         •   Valuation policies and practices;
         •   Types of assets held;
         •   Side letter arrangements;
         •   Trading practices; and
         •   Other information the SEC determines necessary.

    Other Provisions Directed at Investment Advisers
New Short Sale Reporting Requirements. The Dodd Bill requires short-sellers of equity
   securities to file period reports, bans manipulate short sales and required brokers and
   dealers to notify investors of the short-sale practices regarding loaned securities.

        Short-Sale Reports - Section 13(f)(2) of the Securities Exchange Act now requires public disclosure
         at least monthly of information regarding the short sales of institutional investment managers. The
         SEC will draft rules for the “public disclosure of the name of the issuer and the title, class, CUSIP
         number, aggregate amount of the number of short sales of each security, and any additional
         information determined by the SEC.”
        Enforcement – Section 9(d) now bans manipulative short sales. The SEC will draft rules to ensure
         enforcement options and remedies to deal with violations.
        Investor Notice – Section 15(e) now requires that every registered broker or dealer notify its
         customers that they may elect not to allow their fully paid securities to be used in connection with
         short sales.

It is unclear whether the SEC will require reports of short sales from all sellers or
integrate the short sale reporting requirement with the institutional investment manager
13F process.

     Other Provisions Directed at Investment Advisers
Regulation D Private Offering Process. Within one year, the SEC must adopt rules
disqualifying any securities offerings under Rule 506 of Regulation D ("bad actors") by a
person who:

      is subject to final orders from state and federal regulators barring the person from
       association with certain enumerated regulated industries which:
          • Bars the person from association with an entity or engaging in the business of securities;
          • Constitutes a final order based on a violation of any law or regulation prohibits fraudulent,
            manipulative, or deceptive conduct within the 10 years period ending on the date of the filling
            of the offer or sale.
      has been convicted of any felony or misdemeanor in connection with the purchase or
       sale of any security;
      ability to seek collateral bar from entire securities profession:
          • Amends securities laws to give SEC authority to bar person in one profession (e.g.
            broker/dealers) from all areas of securities industry (e.g. advising).
          • Powerful weapon that will put pressure on SEC to seek penalty in almost every case.

SEC’s Whistleblower Program Under Dodd-Frank
Basic Outline of Program

    SEC must pay “whistleblower” giving “original information” leading to
     enforcement action recovering > $1 million.
    Whistleblower gets 10-30% of monies collected in any related civil &
     criminal case.
    Participants in wrongdoing not barred from collecting reward.
    SEC is required to pass rules by April 15, 2011.

SEC’s Whistleblower Program Under Dodd-Frank
Special Protection for “Whistleblowers”

   Confidentiality: Can report anonymously with lawyer.
        Identity must be disclosed to the SEC by the time the
         whistleblower seeks the award.
        Employer unlikely to learn identity unless & until it is charged by
         SEC, and only then during discovery in enforcement proceedings.
  Protection Against Retaliation: Private right of action for retaliation,
    with remedies of reinstatement, payment of 2x back pay and other

SEC’s Whistleblower Program Under Dodd-Frank
Potential Effects on Internal Compliance Programs

       Current/former SEC Staff have already commented that they expect a
        flood of whistleblower reporting to the SEC.
            Early reports indicate it already has caused a big increase in “tips.”
       Whistleblowers’ interest in reward creates incentive to question SEC
        decisions – and pressure SEC to act.
       Powerful incentive for Employees not to report internally.
       Need to update Internal Compliance Manuals to make sure employees will
        not ignore internal reporting.

SEC’s Whistleblower Program Under Dodd-Frank
Example From SEC’s Prior Insider Trading “Bounty” Program

    Pequot Capital Insider Trading Case (July 2010): Ex-wife of Pequot executive
     finds email on family hard-drive showing that at prior job (Microsoft) he grilled co-
     workers for inside information & gave it to Pequot founder, Arthur Samberg.
        SEC reopened insider trading investigation into Pequot.
        SEC orders Pequot to pay $28 million ($10 million penalty & $18 million
         disgorgement): investigation causes Pequot to shut down.
        SEC awards ex-wife $1 million bounty (statutory maximum of 10% of penalty)
         – highest ever awarded pursuant to Bounty Program.
    Pequot shows SEC will be aggressive and give maximum rewards under
     Whistleblowers Program:
        Whistleblower designed to remedy defects in Bounty Program by requiring
         SEC to pay larger reward of all money collected.
        Bounty Program gave SEC discretion to pay only up to 10% of civil
        In more than 20 years, SEC paid only a handful of bounties.

SEC’s Whistleblower Program Under Dodd-Frank
Suggestions for Updating Internal Compliance Programs

    Re-emphasize that employees have a duty to report wrongdoing internally.
    Highlight that failure to report internally may be participation in or aiding/abetting
     the wrongdoing.
        Grounds for sanctions, including termination from job.
    Note that reporting wrongdoing can lead to promotion, higher salary or other
        Counteracts financial incentive to be “Whistleblower” instead of reporting
    Better practice is not to mention Whistleblower Program;
        Could be viewed as implicit threat/evidence of intent to retaliate.
        Pending criminal action can limit ability to enforce compliance program.


     Enhance Your Compliance Programs

     Educate Your Employees

     Examine Your Operating Procedures
Ease of Issuing Subpoenas and Investigations

      Broad subpoena power:
          Production requests becoming more voluminous;
          Nationwide service of trial subpoenas enable SEC to compel in-
           person testimony;
          SEC seeking incarceration for refusing to cooperate with subpoena
      Senior SEC enforcement staff can bring formal investigations;
      Informal investigations have increased;
      Sweep letters are becoming more common:
          Used as a tool to pinpoint widespread and/or problematic industry

Expanded Causes of Action

    Broadened standard for secondary liability;

    Right to bring aiding-and-abetting claims under all federal securities

    Extraterritorial Jurisdiction.

Expanded Causes of Action (cont.)
Broadened Standard for Secondary Liability

     SEC can utilize control-person liability more aggressively;

     Officers and directors face greater legal risk based on actions of

     Hard to defend – the burden of proof is on the defendant.

Expanded Causes of Action (cont.)
Right to Bring Aiding-and-Abetting Claims Under all Federal Securities

   Lower standard of proof;

   Recklessness replaces actual knowledge and substantial assistance.

Expanded Causes of Action (cont.)
Extraterritorial Jurisdiction
      SEC and DOJ have extraterritorial jurisdiction to enforce international
       violations of anti-fraud regulations.
           Extraterritorial jurisdiction may be invoked in either instance below:
           •    Significant step towards violation within U.S., even if:
                – Final transaction occurred outside U.S., and/or
                – Involved only non-U.S. participants.
           •    Foreseeable substantial effect within the U.S.
      Sarbanes-Oxley gives U.S. courts jurisdiction over foreign accounting firms
       to compel production of audit work papers;
      Confidentiality provisions added to regulations to give comfort to foreign

SEC Budget Doubles By 2015

       $1.3 billion to $2.25 billion in the next 5 years;

       The SEC has access to SEC “Reserve Fund” initially funded with $100

           $50 million/year of the SEC’s income will be apportioned to the
            “Reserve Fund”.

       Result? The SEC has the means to be more aggressive.

Swifter Timeline for Enforcement Actions

        SEC must file an action or notify of intent not to file within 180 days.

            Tighter timeframe than many current investigations.

        180 day extension if Director of Enforcement decides & notifies Chairman

            Staff unlikely to seek extensions because it makes them look bad to

Power to Limit Arbitration Clauses

        Authorizes SEC to “prohibit, or impose conditions or limitations on the use”
         of Arbitration Agreements;

            Must be in “public interest and for the protection of investors.”

        Likely means SEC will review arbitration clauses for fairness and abuse.

SEC’s Current Enforcement Priorities

       SEC has formed 5 specialized units to focus on areas of interest.
          Asset Management: Focus on valuation, strategy misrepresentation,

          Market Abuse: Insider trading, high-frequency/algorithm trading, institutional
           trading & platforms.

          Structured & New Products: Mortgage-backed and similar products – focus
           on concealing risk, structuring & marketing of products, and adviser fraud.

          Municipal Securities: Pay-to-play, under funded pensions, risk disclosures.

          Foreign Corrupt Practices Act: Cases involving overseas bribery/fraud;
           coordinate with Department of Justice on criminal issues.

  Tailor compliance manuals to particular business needs;
  Adopt and implement insider trading procedures;
  Ensure that marketing materials contain appropriate disclosures;
  Document a review of all cross trades (including rebalancing);
  Document pre-approval of personal trades in a manner consistent with
   internal policies and review trades for potentially improper trading;
  Maintain detailed records of the valuation of assets, including:
     Disclose how you will value hard to value assets;
     Disclose the use of side pocket accounts.
  Review proxy voting records to ensure votes have been cast in accordance
   with procedures and in the best interest of investors;
  Retain thorough and organized records of all transactions, brokerage
   statements, and financial reports.

Sadis & Goldberg LLP

                   Ron S. Geffner, Head of Financial Services
                             Paul Fasciano, Partner
                             Lance Friedler, Partner
                             Steven Huttler, Partner

                       Douglas Hirsch, Head of Litigation
                          Charles Dufresne, Of Counsel
                           Sam Lieberman, Of Counsel
                             Jennifer Rossan, Partner

            Daniel G. Viola, Head of Regulatory Defense & Compliance


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